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  • American Economic Association

    Time Discounting and Time Preference: A Critical ReviewAuthor(s): Shane Frederick, George Loewenstein and Ted O'DonoghueSource: Journal of Economic Literature, Vol. 40, No. 2 (Jun., 2002), pp. 351-401Published by: American Economic AssociationStable URL: .Accessed: 10/04/2014 02:22

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  • Journal of Economic Literature Vol. XL (June 2002), pp. 351-401

    Time Discounting and Time Preference: A Critical Review


    1. Introduction

    I NTERTEMPORAL CHOICES-decisions involving tradeoffs among costs and

    benefits occurring at different times- are important and ubiquitous. Such deci- sions not only affect one's health, wealth, and happiness, but, may also, as Adam Smith first recognized, determine the economic prosperity of nations. In this paper, we review empirical research on intertemporal choice, and present an overview of recent theoretical formula- tions that incorporate insights gained from this research.

    Economists' attention to intertempo- ral choice began early in the history of the discipline. Not long after Adam Smith called attention to the impor- tance of intertemporal choice for the

    wealth of nations, the Scottish economist John Rae was examining the sociologi- cal and psychological determinants of these choices. In section 2, we briefly review the perspectives on intertempo- ral choice of Rae and nineteenth- and early twentieth-century economists, and describe how these early perspectives interpreted intertemporal choice as the joint product of many conflicting psychological motives.

    All of this changed when Paul Sam- uelson proposed the discounted-utility (DU) model in 1937. Despite Samuel- son's manifest reservations about the normative and descriptive validity of the formulation he had proposed, the DU model was accepted almost in- stantly, not only as a valid normative standard for public policies (e.g., in cost- benefit analyses), but as a descriptively accurate representation of actual behav- ior. A central assumption of the DU model is that all of the disparate mo- tives underlying intertemporal choice can be condensed into a single parameter- the disc.ount rate. In section 3 we exam- ine this and many other assumptions underlying the DU model. We do not present an axiomatic derivation of the model, but instead focus on those features that highlight the implicit psychological assumptions underlying the model.

    1 Frederick: Sloan School of Management, Mas- sachusetts Institute of Technology. Loewenstein: Department of Social and Decision Sciences, Carnegie Mellon University. O'Donoghue: De- partment of Economics, Cornell University. We thank Colin Camerer, David Laibson, John McMillan, Drazen Prelec, Daniel Read, Nachum Sicherman, Duncan Simester, and three anony- mous referees for useful comments. We thank Cara. Barber, Rosa Blackwood, Mandar Oak, and Rosa Stipanovic for research assistance. For finan- cial support, Frederick and Loewenstein thank the Integrated Study of the Human Dimensions of Global Change at Carnegie Mellon University (NSF Grant SBR-9521914), and O'Donoghue thanks the National Science Foundation (Award SE'S-0078796).


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  • 352 Journal of Economic Literature, Vol. XL (June 2002)

    Samuelson's reservations about the descriptive validity of the DU model were justified. Section 4 reviews the growing list of "DU anomalies"- patterns of choice that are inconsistent with the model's theoretical predic- tions. Virtually every assumption under- lying the DU model has been tested and found to be descriptively invalid in at least some situations. Moreover, as we discuss at the end of the section, these anomalies are not anomalies in the sense that they are regarded as errors by the people who commit them. Unlike many of the better-known expected- utility anomalies, the DU anomalies do not necessarily violate any standard or principle that people believe they should uphold.

    The insights about intertemporal choice gleaned from this empirical re- search have led to the proposal of nu- merous alternative theoretical models, which we review in section 5. Some of these modify the discount function, per- mitting, for example, declining discount rates or "hyperbolic discounting." Oth- ers introduce additional arguments into the utility function, such as the utility of anticipation. Still others depart from the DU model more radically, by in- cluding, for instance, systematic mis- predictions of future utility. Many of these new theories revive psychological considerations discussed by Rae and other early economists that were extin- guished with the adoption of the DU model and its expression of intertem- poral preferences in terms of a single parameter.

    In section 6, we review attempts to estimate discount rates. While the DU model assumes that people are charac- terized by a single discount rate, this literature reveals spectacular variation across (and even within) studies. The failure of this research to converge to- ward any agreed-upon average discount

    rate stems partly from differences in elicitation procedures. But it also stems from the faulty assumption that the var- ied considerations that are relevant in intertemporal choices apply equally to different choices and thus that they can all be sensibly represented by a single discount rate.

    Throughout the paper, we stress the importance of distinguishing among the varied considerations that underlie in- tertemporal choices. We distinguish time discounting from time preference. We use the term time discounting broadly to encompass any reason for caring less about a future consequence, including factors that diminish the ex- pected utility generated by a future consequence, such as uncertainty or changing tastes. We use the term time preference to refer, more specifically, to the preference for immediate utility over delayed utility. In section 7, we push this theme further, by examining whether time preference itself might consist of distinct psychological traits that can be separately analyzed. Section 8 concludes.

    2. Historical Origins of the Discounted Utility Model

    The historical developments that cul- minated in the formulation of the DU model help to explain the model's limi- tations. Each of the major figures in the development of the DU model-John Rae, Eugen von B6hm-Bawerk, Irving Fisher, and Paul Samuelson-built upon the theoretical framework of his predecessors, drawing on little more than introspection and personal obser- vation. When the DU model eventually became entrenched as the dominant theoretical framework for modeling in- tertemporal choice, it was due largely to its simplicity and its resemblance to the familiar compound interest formula,

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  • Frederick, Loewenstein, and O'Donoghue: Time Discounting 353

    and not as a result of empirical research demonstrating its validity.

    Intertemporal choice became firmly established as a distinct topic in 1834, with John Rae's publication of The So- ciological Theory of Capital. Like Adam Smith, Rae sought to determine why wealth differed among nations. Smith had argued that national wealth was de- termined by the amount of labor allo- cated to the production of capital, but Rae recognized that this account was in- complete because it failed to explain the determinants of this allocation. In Rae's view, the missing element was "the effective desire of accumulation"-a psychological factor that differed across countries and determined a society's level of saving and investment.

    Along with inventing the topic of in- tertemporal choice, Rae also produced the first in-depth discussion of the psy- chological motives underlying inter- temporal choice. Rae believed that intertemporal-choice behavior was the joint product of factors that either pro- moted or limited the effective desire of accumulation. The two main factors that promoted the effective desire of accumulation were the bequest motive ("the prevalence throughout the society of the social and benevolent affections," p. 58) and the propensity to exercise self-restraint ("the extent of the intel- lectual powers, and the consequent prevalence of habits of reflection, and prudence, in the minds of the mem- bers of society," p. 58). One limiting factor was the uncertainty of human life:

    When engaged in safe occupations, and living in heal


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